Audit PPE (Property Plant and Equipment)
Overview
Property plant and equipment or PPE are usually material items on the balance sheet; hence to audit PPE, it is very important to perform proper audit procedures in order to obtain sufficient appropriate audit evidence for making a proper conclusion on PPE accounts.
In the audit of PPE, the inherent risk of PPE involves more on the existence and valuation of their balances. This is due to the risk of overstatement of PPE is higher than the risk of an understatement.
The inherent risk of PPE is that the client may over overstate the balance by including fictitious assets or capitalize the costs, such as repair and maintenance costs, which should be the expense. Meanwhile, the valuation issue is usually related to the estimate of the useful life of the PPE which may result in an understatement of depreciation expense.
Audit Assertions for PPE
In the audit of PPE, we usually test the audit assertions included in the table below:
| Audit assertions for PPE | |
|---|---|
| Existence | PPE reported on the balance sheet really exists at the reporting date. |
| Valuation | PPE balances truly reflect their actual economic value as at reporting date. |
| Completeness | All PPE transactions that should have been recorded have been recorded. |
| Rights and obligations | The client has ownership rights for PPE as of the reporting date. |
Existence and valuation assertions are the most relevant assertions in the audit of PPE. This is because the client tends to overstate the value of PPE rather than understate. Hence, we usually pay more attention to the areas related to these two audit assertions.
Audit Procedures for PPE
In the audit procedures for PPE, we need to test various audit assertions, including existence, valuation, completeness and rights and obligations.
This is so that we can make sure PPE balances reported in the financial statements actually exist and reflect their actual economic value. Additionally, we need to evaluate whether all PPE items are included and if they really belong to the client.
Completeness
For the PPE audit, we test completeness assertion to ensure that all PPE transactions that occurred during the year have been recorded. Lack of completeness would result in the understatement of PPE.
Example: tests of completeness in PPE audit include:
- Reconcile and compare the PPE register with the general ledger
- Select a sample of PPE items that physically exist
- Trace the selected items to the PPE register
We need to obtain proper explanations if there are any differences between the PPE register and the general ledger.
Existence
When we perform the PPE audit, we test the existence assertion to ensure that the PPE balances shown on the balance sheet really exist at the reporting date.
Example: tests of existence on PPE audit include:
- Select a sample of items in PPE register
- Perform physical inspection on the selected items
When performing the physical inspection of PPE, we need to make sure not only that the selected items really exist, but they also need to be in a working condition.
Valuation
In the audit of PPE, we test the valuation assertion to ensure that the PPE balances are mathematically correct and proper valuation method has been made. The valuation assertion usually relates to the deprecation of PPE.
Hence, we usually perform the test of PPE depreciation in this section.
Example: tests of depreciation in the audit of PPE:
- Review the client’s depreciation method to evaluate whether it is in accordance with the applicable accounting standards
- Examine the useful life of PPE to evaluate whether the client’s estimate is reasonable, e.g. by comparing with industry standard. Professional judgment is required and very important here.
- Perform recalculation on the depreciation of PPE
- Compare the result of recalculation to the client’s figures.
Rights and obligations
Right and obligation assertion tests whether the client has the right and ownership of all PPE shown on the financial statements as at reporting date.
Example: tests of rights and obligations in the PPE audit include:
- Select a sample of PPE items in the register
- Examine the title documents or title deeds of the selected items to ensure they really belong to the client
Summary
All in all, existence and valuation assertions are the primary concerns in the audit of PPE. The existence of PPE itself is the high-risk area as the misstatement in this area could be due to the intentional act of cooking the books.
On the other hand, misstatement occurred in the area of valuation tends to be an understatement of depreciation. In this case, they impact both the balance sheet and income statement; and it may result in an overstatement of both PPE and net profit.